As British chip designer Arm prepares to raise about $5 billion in an initial public offering (IPO) on Thursday, its China business has become a serious point of concern.

The SoftBank-owned firm used many pages of its IPO prospectus to warn investors of risks related to its exposure to China at a time of rising tension between Washington and Beijing over chip technology.

Its regulatory filing last month revealed that a quarter of its sales come from China, through an unusual relationship with an entity it does not control and with which it has a complex history.

Arm China is "an entity that operates independently of us and is our single largest customer," the company said in its prospectus. "Neither we nor SoftBank Group control the operations of Arm China."

Arm, which is based in Cambridge, added that the scale of its business in China made it "particularly susceptible to economic and political risks," which could be worsened by tensions between the country and the United States or the United Kingdom.

The company has long been vulnerable in this area, which may have already contributed to a lower market valuation than SoftBank was expecting.

Arm blamed an economic slowdown in China as well as "factors related to export control and national security matters" for slower growth in royalty revenues from China in its fiscal year to March. Total revenue from China did increase in that period, however.

Royalties are hugely significant for Arm, which gets a fee from each chip developed using its products. The company relies on royalties and licensing for most of its income.

Arm said Wednesday it priced its shares at $51 each, raising as much as $4.9 billion. The tally could rise to $5.2 billion if banks exercise an option to buy additional shares, valuing the chip designer at as much as $54.5 billion.

That's less than the $64 billion valuation implied when SoftBank bought a remaining 25% stake in the company from its Vision Fund unit just last month.

Arm has declined to comment.

Concerns about China are likely to have been "built into IPO pricing expectations already, although a worst-case scenario of increased US sanctions [or] trade restrictions probably is not," Kirk Boodry, an investment advisor at Astris Advisory, a Japanese investment research firm, told CNN.

Geopolitical tensions

Arm was publicly listed until 2016, when Japan's SoftBank bought it for $32 billion.

Four years later, SoftBank tried to sell Arm to Nvidia for $40 billion, in what would have been the biggest chip deal of all time. But it didn't pass muster with global antitrust regulators, and was called off in February 2022.

Now, Arm's return to the stock market is being closely watched as it promises to be the biggest US IPO since 2021.

SoftBank CEO Masayoshi Son has touted it as an AI company that could have "exponential growth," and promised that ChatGPT-like services will eventually be offered on Arm-designed machines.

"The value of chips, and Arm's technology, has maybe never been more in demand from the global economy," said Kyle Stanford, lead venture capital analyst at PitchBook.

But Arm is a middleman in the semiconductor industry, which is a key source of tension in US-China relations. Both countries are racing to boost their prowess in the sector, and each side has recently enacted export controls aimed at limiting the other's capacity.

"Chip tensions will never go away," Stanford argued. "Political and regulatory pressure is likely to increase."

On Tuesday, former US Securities and Exchange Commission Chairman Jay Clayton told US lawmakers that large public companies with major exposure to China should be prompted to disclose specific risks associated with the country, "and what type of scenario planning they have done in the event of abrupt decoupling."

Although US officials have insisted that America is not seeking to decouple from China, they have pointed to the importance of reducing its reliance on the world's second largest economy.

A complex relationship

In its filing, Arm said it held just a "4.8% indirect ownership interest in Arm China," through a 10% non-voting stake in a SoftBank-controlled entity that owns less than half of the Chinese company.

While such convoluted corporate structures aren't unique in China, "in my view, it is very problematic," said Ivana Delevska, founder and chief investment officer of asset manager Spear Invest.

"Investors of other companies are just waking up to this fact in light of increased tensions," she added.

Arm has had trouble with Arm China before. In its filing, it said the business has a record of late payments.

"Although these historical issues did not have a material impact on our operations, any future failure to pay us the amounts we are owed ... could have a material adverse effect on our business," Arm said.

Arm China has also been subject to a legal battle with its former CEO, Allen Wu.

Since April 2022, Wu and entities effectively controlled by him have lodged several lawsuits in Chinese courts against Arm China, "seeking to challenge certain aspects of Arm China's corporate governance and the actions of Arm China's board of directors," Arm said in its filing.

As of August, the cases had been resolved in favor of Arm China, it said, but the outcome could still be appealed. potentially hurting the British firm in the future.

That hasn't stopped many of the biggest names in global tech from jumping on board.

Companies including Apple (AAPL), Google (GOOGL), Nvidia (NVDA), AMD (AMD), Samsung and TSMC (TSM) have indicated interest in acting as cornerstone investors in the offering, according to a filing last week.

Delevska said the interest reflected Arm's strong position in the industry and had helped to prop up its overall valuation.

"I believe it is good timing for the IPO," she added. "Investors will just have to price in the China risk."